6 min readDec 8, 2024 04:44 PM IST
First published on: Dec 6, 2024 at 04:20 AM IST
Failure has many fathers. Even when most of the contemporaneous macroeconomic data were available for the second quarter of the financial year, RBI Governor Shaktikanta Das was confidently predicting 7 per cent growth. The actual estimate came in at 5.4 per cent. What economic calculations caused this big miss, and what does it mean for India’s march towards Viksit Bharat 2047? On the latter question, not much at present. Growth rates are not cast in stone, long-term or otherwise. For most economists, macro growth rates are a function of policy — if it was all a random walk, economists and other policy makers would be redundant. Policy may not affect outcomes over the very short-term, but over a few quarters definitely so. Does a competitive exchange rate matter? Can tariffs affect growth? Can MSPs, with import controls, affect food inflation? We could go on but you get the drift — policies affect outcomes.
Over the last two years we have been confident that India’s path towards a high-income country status by 2047 was reasonably possible. Many others felt that was a 23-year pipe dream given that the long-term GDP growth in India had averaged just 6.1 per cent. These same experts now claim that they are not surprised by the close to 3 percentage point decline in GDP growth from the 8 per cent plus peaks five quarters ago. We are not surprised either. As recently as the IEG-Ministry of Finance Kautilya Economic Conclave in September, we had flagged the possible derailment of the Indian growth story due to two mega road-blocks — high rates of taxation and tax collection, and the rapid decline in foreign investment. On a short-term basis, with possible consequences for mid-term health, the level of real interest rates also do matter.
Given that the RBI gives its decision on policy rates today, let us discuss real policy rates first. There are two issues that merit a discussion: Should RBI be looking at real policy rates based on core inflation or headline inflation? Regardless, India has been running an unduly tight monetary policy for the last two post-Covid years. The median real repo rate for core inflation in non-advanced economies is 1.2 per cent, for India it is 2 per cent. The median real repo rate for headline inflation in non-advanced economies is 0.9 per cent, for India it is 1.4 per cent. Real policy rates during the much-touted growth success story 2004-2011 were minus 1 per cent. It is well accepted that India had contractionary monetary policy over the last eight quarters and in the process, MPC has slowed the economy much more than their projections.
In 2023, all tax revenue (Centre, state, local) to GDP ratio approached 19 per cent. Most critics of Viksit Bharat dreams allude to the fact that we are way behind our competitors in East Asia with unusually high import tariffs damaging our competitiveness, efficiency and growth. Yet they turn a blind eye to the data on the low all-tax revenue rates in East Asia of 17 per cent, China 16 per cent and Vietnam 13 per cent. Needless to mention that tax revenues rise with GDP and East Asia has a much higher level of per capita income than India.
Wrong assessments often result in misguided policy calls. An example of such policies would be on foreign direct investment. It has been recognised by all development institutions that these two components are critical for the Viksit path — infrastructure investment and FDI. The importance of both is intuitively obvious. On the former, full marks to the two big-infrastructure-enthusiast prime ministers — Atal Bihari Vajpayee and Narendra Modi. On the latter, the withdrawal from Bilateral Investment Treaties (BITs) was a significant error in judgement on part of policymakers. There is sufficient evidence to warrant an urgent rethink on this issue in light of the sharp decline in foreign investments. Foreign investors are less likely to invest without enforceability of contract, timely resolution of conflicts and predictability in judicial principles and actions. Investors would search for the best place to park their funds and withdrawing from BITs increases foreign investor risks without increasing returns. Slower growth over coming years may even result in a re-examination of the returns that may further dampen investor sentiment — both domestic and foreign.
The Economic Survey 2024 wants India to play third fiddle to the China infrastructure BRI (Belt and Road Initiative) monopoly and that we should invite and welcome Chinese foreign investment. Yet, the Survey is coy about, if not out of sync with, India’s misguided policy of “banning” BITs. Another unresolved issue is the retrospective changes in tax policies such as the removal of indexation benefits on real estate assets. The ghost of retrospective tax continues to haunt India’s economic prospects. The issue should have been settled by legislative restrictions on such changes, but all three branches of the government regularly make retrospective changes against the spirit of improving “Ease of Living”.
Recent policy changes such as retrospective tax changes, restrictions on certain kinds of expenditures through credit cards and withdrawal from BITs are signs of a gradual reversion to the command-and-control type of economy. The state — or the empire — wants to strike back in defiance of the Prime Minister’s repeated advice on limiting the role of the state in the lives of citizens.
The sooner we get rid of the remaining shackles of Nehruvian socialism that continue to influence statist impulses within the government, the sooner we can avoid making policy errors that dampen our growth prospects. There is a deep divide between the Prime Minister’s vision of limiting the role of the state and the bureaucracy and the reality of Nehruvian impulses in recent policies.
More countries have lost the growth momentum by taking good growth to be their right. No country is entitled to a 6 or a 7 per cent growth rate. India’s growth challenge is partly driven by the large divergence between its per-capita income levels and the aggregate size of its economy. The expectation is that institutions and policy making will lead the world’s soon-to-be-fourth-largest economy on the road to becoming Viksit Bharat, yet we have to contend with policies and standards of an economy with a sub $3,000 per-capita income. We aspire to be a developed economy; we should begin to act on our ambition.
Bhalla is former Executive Director at IMF and Bhasin is a New York-based economist. Views are personal
No country is entitled to a 6 or a 7 per cent growth rate. India’s growth challenge is partly driven by the large divergence between its per-capita income levels and the aggregate size of its economy. 
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